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November 08, 2008

Debt Trap
by Doug Noland

For the week, the S&P500 fell 3.9% (down 36.6% y-t-d) and the Dow declined 4.1% (down 32.6%). The Transports were hit for 5.7% (down 19.8%) and the Morgan Stanley Cyclicals 5.4% (down 49.5%). So-called defensive stocks held up better, with the Utilities about unchanged (down 30.8%) and the Morgan Stanley Consumer index declining 2.2% (down 25%). The broader market gave back some of last week's outperformance. The small cap Russell 2000 dropped 5.9% (down 34%), and the S&P400 Mid-Caps fell 5.1% (down 37.1%). The NASDAQ100 dropped 4.7% (down 39%), the Morgan Stanley High Tech index fell 5.7% (down 42.9%), and the Semiconductors sank 6.8% (down 45.3%). The Street.com Internet lost 4.2% (down 35.9%), and the NASDAQ Telecommunications index declined 3.8% (down 39.9%). The Broker/Dealers were hit for 7.4% (down 59.6%) and the Banks 8.2% (down 39.4%). With Bullion recovering $13, the HUI Gold index gained 3.7% (down 50.9%).

One-month Treasury bill rates ended the week at 0.08% and three-month yields at 0.28%. Two-year government yields dropped 23 bps to 1.33%. Five-year T-note yields sank 25 bps this week to 2.56%, and 10-year yields dropped 18 bps to 3.78%. Long-bond yields declined 12 bps to 4.27%. The implied yield on 3-month December '09 Eurodollars sank 40 bps to 2.44%. Benchmark Fannie MBS yields fell a notable 48 bps to 5.55%. The spread between benchmark MBS and 10-year T-notes narrowed 31 to a one-month low 177 bps. Agency 10-yr debt spreads declined 6 to 114 bps. The 2-year dollar swap spread declined 13.75 to 107.50, and the 10-year dollar swap spread declined 6.5 to 41.75. Corporate bond spreads were mixed. An index of investment grade bond spreads narrowed 2 to 221 bps, while an index of junk bond spreads widened 20 to 949 bps.

Investment-grade debt issuance included Altria $6.0bn (600bp over), Virginia E&P $700 million, GATX $200 million, and Atlantic City Electric $250 million.

I saw no junk or convert issues.

International issuance this week included BP Capital $3.0bn.

German 10-year bund yields fell 12 bps to 3.675%. The German DAX equities index declined 1.0% (down 38.8% y-t-d). Japanese 10-year "JGB" yields increased 4 bps to 1.51%. The Nikkei 225 dropped 4.9% (down 43.9% y-t-d). Emerging markets were mixed to higher. Brazil's benchmark dollar bond yields dropped 32 bps to 8.13%. Brazil's Bovespa equities index declined 1.6% (down 42.6% y-t-d). The Mexican Bolsa dropped 2.8% (down 32.7% y-t-d). Mexico's 10-year $ yields were little changed at 7.59%. Russia's RTS equities index added 0.3% (down 66.8% y-t-d). India's Sensex equities index rallied 1.8%, with y-t-d losses reduced to 50.9%. China's Shanghai Exchange incrased 1.1%, with y-t-d losses of 66.8%.

Freddie Mac 30-year fixed mortgage rates dropped 26 bps to 6.20% (down 4bps y-o-y). Fifteen-year fixed rates dropped 31 bps to 5.88% (down 2bps y-o-y). One-year ARMs fell 13 bps to 5.25% (down 25 bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 16 bps this week to 7.49% (up 94bps y-o-y).

Bank Credit dropped $64.5bn to $10.011 TN (week of 10/29). Bank Credit has expanded $798bn y-t-d, or 10.2% annualized. Bank Credit posted a 52-week rise of $893bn, or 9.8%. For the week, Securities Credit fell $35.7bn. Loans & Leases declined $28.7bn to $7.244 TN (52-wk gain of $550bn, or 8.2%). C&I loans decreased $6.1bn, with y-t-d growth of 13.3%. Real Estate loans gained $6.5bn (up 6.7% y-t-d). Consumer loans added $0.9bn, while Securities loans dropped $31.8bn. Other loans increased $1.7bn.

M2 (narrow) "money" supply dropped $48.2bn to $7.877 TN (week of 10/27). Narrow "money" has expanded $415bn y-t-d, or 6.7% annualized, with a y-o-y rise of $471bn, or 6.4%. For the week, Currency rose $4.3bn, and Demand & Checkable Deposits jumped $28.3bn. Savings Deposits sank $88.5bn, while Small Denominated Deposits gained $10.1bn. Retail Money Funds slipped $2.4bn.

Total Money Market Fund assets (from Invest Co Inst) jumped $70bn to $3.608 TN, with a y-t-d expansion of $494bn, or 18.8% annualized. Money Fund assets have posted a one-year increase of $607bn (20.2%).

The Asset-Backed Securities (ABS) market remains pretty much closed down. Year-to-date total US ABS issuance of $129bn (tallied by JPMorgan's Christopher Flanagan) is running at 25% of comparable 2007. Home Equity ABS issuance of $351 million compares with 2007's $232bn. Year-to-date CDO issuance of $30bn compares to the year ago $300bn.

Total Commercial Paper outstanding rose another $50.5bn this week to a one-month high $1.600 TN, with CP down $185bn y-t-d. Asset-backed CP increased $11.1bn, with 2008 posting a decline of $40.5bn. Over the past year, total CP has contracted $267bn, or 14.3%.

Federal Reserve Credit surpassed $1.0 Trillion for the first time in September and rose above $2.0 Trillion last week. For the week, Fed Credit surged $183bn to a record $2.056 TN, with a historic 8-wk increase of $1.168 Trillion. Fed Credit has expanded $1.82 TN y-t-d (156% annualized) and $1.191 Trillion y-o-y (138%). Fed Foreign Holdings of Treasury, Agency Debt last week (ended 11/5) increased $8.1bn to $2.494 TN. "Custody holdings" were up $438bn y-t-d, or 24.6% annualized, and $462bn y-o-y (22.7%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - have dropped a notable $145bn over the past three weeks. During the past year reserves were up $864bn, or 14.5%, to $6.801 TN.

Global Credit Market Dislocation Watch:

November 5 - Wall Street Journal (Kelly Evans): "Banks continue to tighten lending terms for the nation's consumers and businesses... The Federal Reserve's latest survey of banks' senior loan officers showed that a large majority of the 76 U.S. and foreign-based respondents clamped down on lending in the past three months... Also, separate reports Monday showed manufacturing activity slowed, and construction spending fell... Some 95% of banks in the U.S. said they tightened price terms on commercial and industrial loans to large and midsize firms... A total of 85% tightened lending standards, compared with 60% in the previous three-month period... Roughly 60% of U.S. banks tightened lending standards on credit-card loans and other types of consumer loans, while about half said they raised the minimum required credit scores for such loans."

November 5 - MarketNews International (Steven K. Beckner): "Dallas Federal Reserve Bank President Richard Fisher said Tuesday he 'would not be surprised' if the Fed's assets balloon to $3 trillion by the end of year. Fisher... suggested inflation has ceased to be an issue for now because the economy is 'geared to the downside with a kind of turbulent ferocity.' He said it 'will take time' before confidence is reestablished."

November 7 - Washington Post (David Cho, Peter Whoriskey and Neil Irwin): "The federal government is preparing to take tens of billions of dollars in ownership stakes in an array of companies outside the banking sector, dramatically widening the scope of the Treasury Department's rescue effort beyond the $250 billion set aside for traditional financial firms, government and industry officials said. Treasury officials are finalizing the new program, which could ultimately involve hundreds of billions of the $700 billion rescue package, though the initiative is unlikely to be announced until the end of next week at the earliest."

November 6 - Dow Jones (Siobhan Hughes and Henry Pulizzi): "The White House... told automakers and other companies to submit applications for government loans, one day after the Bush administration took steps to get the $25 billion program running ahead of schedule. 'We encourage the automakers and other eligible companies to file their applications to obtain loans for qualifying projects so they can produce more fuel-efficient vehicles which consumers are demanding,' White House spokesman Tony Fratto said."

November 7 - Bloomberg (Jeff Green and Mike Ramsey): "General Motors Corp., seeking federal aid to avoid collapse, said it may not have enough cash to keep operating this year and will fall 'significantly short' of the amount needed by the end of June unless the auto market improves or it raises more capital. The largest U.S. automaker reported a $4.2 billion third-quarter operating loss..."

November 7 - Bloomberg (Bill Koenig): "Ford Motor Co., with U.S. sales shredded by the worst financial crisis since the Great Depression, posted a third-quarter operating loss of $2.98 billion and said it used up $7.7 billion in cash."

November 7 - Bloomberg (John Hughes): "General Motors Corp., Ford Motor Co. and Chrysler LLC, strapped for cash as sales plunge, are seeking $50 billion in federal loans to help them weather the worst auto market in 25 years, a person familiar with the matter said. The package would be $25 billion for health-care spending and $25 billion for general liquidity that could be delivered in different ways, including short-term borrowing from the Federal Reserve..."

November 6 - Wall Street Journal (Prabha Natarajan and Robin Sidel): "A key part of the bond market that is essential for making credit-card, auto, education and mortgage loans still shows little sign of improvement -- a development that could have repercussions for both banks and consumers. New data on this 'asset securitization' market from... Dealogic reveal that issuers sold just one $500 million securitization deal for the entire month of October. That compares with $50.7 billion worth of deals made one year earlier, and a fraction of the overall $2.5 trillion market for buying and repackaging consumer-based loans."

November 4 - Wall Street Journal (Kelly K. Spors, Raymund Flandez and Phred Dvorak): "When entrepreneurs can't get conventional loans, they traditionally turn to loans backed by the Small Business Administration. But in recent months -- as many banks turned away businesses and slashed credit lines -- SBA lending also has dried up substantially. The retrenchment has become especially pronounced in the past couple of weeks... The SBA reported last week that loan volumes made under its flagship 7(a) loan program fell 30% in the fiscal year ended Sept. 30. And in October, overall SBA loan volumes were 50% lower than in October 2007..."

November 3 - Bloomberg (Joe Carroll and Mario Parker): "VeraSun Energy Corp. and U.S. ethanol makers backed by Bill Gates and Vinod Khosla are failing after wrong-way bets on corn prices overwhelmed $20 billion in federal aid and government-guaranteed demand for the fuel additive. VeraSun, the second-largest U.S. ethanol producer, was the latest in a string of distillers stung by imploding hedges when the... company filed for Chapter 11 bankruptcy protection on Oct. 31. Biofuel Energy... and at least six other distillers have shut down or curtailed operations because of volatile corn prices and narrowing ethanol margins... Investors from Wall Street to Silicon Valley took a piece of the action after Congress and the White House ordered oil companies three years ago to almost double ethanol use by 2012."

November 7 - Bloomberg (Ari Levy and David Mildenberg): "GMAC LLC may leave thousands of individuals on the hook for about $15 billion of junk-rated debt unless the auto and home lender finds a way to pay its bills. GMAC, the largest lender to car dealers of General Motors Corp., issued more than $25 billion of debt called SmartNotes over the past decade to retail investors. While GMAC has paid off the debts as they matured, five straight unprofitable quarters raised doubt about GMAC's survival, and SmartNotes due in July 2020 have lost about two-thirds of their value."

November 7 - Wall Street Journal (Annelena Lobb): "Dividends are another investor mainstay weakening in this market, along with 401(k)s, variable annuities, money-market funds and other once-reliable vehicles. This year, dividend payouts have taken a hit... Thirty-six companies listed on S&P's 500-stock index have cut or suspended dividends 46 times in 2008, sucking some $33.3 billion from investors' pockets... From that sum, $30.8 billion came from financial companies, representing 37 individual actions."

November 5 - Bloomberg (Christian Vits): "Banks deposited a record amount of cash with the European Central Bank overnight, suggesting they remain reluctant to lend to each other even as money-market rates fall. Banks yesterday lodged 295.9 billion euros ($379.5 billion) in the ECB's overnight deposit facility... At the same time, the ECB continues to pump additional cash into the banking system in an attempt to facilitate interbank lending."

November 5 - Bloomberg (Christine Richard): "Ambac... posted a third-quarter loss as it set aside at least $3 billion to pay anticipated claims. The net loss widened to $2.43 billion... from $360 million..."

November 5 - Bloomberg (Abigail Moses): "Sellers of credit-default swaps on bonds sold by Glitnir Banki hf may pay almost 1.6 billion euros ($2 billion) to settle contracts triggered when the Icelandic government took control of the bank last month. An auction by 14 dealers set a final value of 3 cents on the euro for Glitnir senior bonds today."

November 5 - Bloomberg (Bob Chen and Kyoungwha Kim): "Asian regulators may limit currency derivatives after losses helped push the South Korean won to a decade low, led to lawsuits in India and caused shares of China's Citic Pacific Ltd. to collapse. South Korea will announce measures by December to restrict company purchases of the contracts to a percentage of overseas earnings, Hyeon Jung Gun, head of Korea's Financial Supervisory Services derivatives market team, said... 'There were companies that went over-hedging and banks that failed to remind options buyers of the embedded risk,' Hyeon said. 'Under new regulations, companies will have access to derivative products based only on real demand.'"

November 5 - Bloomberg (Sebastian Alison and Maria Levitov): "Russian President Dmitry Medvedev said it's 'time to act' to create a new global economic system and blamed the U.S. for the worst financial crisis since the 1930s. 'Radical' reforms are needed, Medvedev told Russian lawmakers... The U.S., the European Union and the BRIC countries -- Brazil, Russia, India and China -- must work together to create an economic system which will be 'more fair and more secure,' Medvedev said in his first state of the nation address... 'We must radically reform the political and economic systems. Russia, at all events, will insist on this.'"

Currency Watch:

The dollar index added 0.3% to 85.91. For the week on the upside, the Canadian dollar increased 2.0%, the New Zealand dollar 1.7%, the Australian dollar 0.9%, the Taiwanese dollar 0.5%, and the Japanese yen 0.2%. On the downside, the South African rand declined 3.8%, the South Korean won 2.9%, the British pound 2.7%, the Norwegian krone 2.6%, the Swedish krona 1.9%, the Swiss franc 1.8%, and the Singapore dollar 0.9%. In the emerging currencies, the Iceland krona fell 7.2%, the Hungarian forint 4.5%, the Czech koruna 4.3%, and the Polish zloty 3.4%.

Commodities Watch:

Gold recovered 1.8% to $737, and Silver rallied 3.0% to $10.02. December Crude sank $6.79 to $61.02. December Gasoline dropped 9.7% (down 45% y-t-d), while December Natural Gas was unchanged (down 9% y-t-d). December Copper declined 6.5%. December Wheat fell 2.8% and Corn 6.5%. The CRB index dropped 4.3% (down 28.4% y-t-d). The Goldman Sachs Commodities Index (GSCI) sank 6.5% (down 31% y-t-d).

China Watch:

November 6 - Bloomberg (Rob Delaney): "China's Deputy Finance Minister Li Yong said his country will assist in a worldwide effort to provide liquidity to help relieve a worldwide credit crisis. China will provide assistance through the International Monetary Fund, Li said...in Trujillo, Peru, where Asia- Pacific Economic Cooperation finance officials are meeting this week."

November 3 - Bloomberg (Michael Dwyer): "India and China are accelerating efforts to prop up growth as a global slump threatens the world's fastest-expanding major economies. The Reserve Bank of India on Nov. 1 lowered its benchmark interest rate for the second time in two weeks... China's central bank removed temporary controls over loans to maintain 'relatively fast' growth, Xinhua News Agency reported..."

November 5 - Wall Street Journal (Patricia Jiayi Ho): "Growth in China's once-roaring auto market has slowed to a near-crawl... Car-producing giants such as General Motors Corp. and Ford Motor Co. have been looking to emerging markets -- mainly China and India -- to provide a much-needed counterbalance to declining sales in the U.S. and Europe... Until midyear, Chinese auto sales had grown at 14% to 24% every month year-to-year..."

November 5 - Bloomberg (Luo Jun): "Wang Yi, who employs 300 people making children's raincoats on China's east coast, is worried his company won't survive the next year as exports dry up. The apparel manufacturer... needs a 600,000 yuan ($88,000) loan by Jan. 31 to stay afloat. China's state-owned banks rejected his previous applications... China's largest banks... are resisting government efforts to boost lending to 42 million small and medium-size companies that drove the economic boom of the past decade... Half the nation's toy exporters have closed this year, and 67,000 smaller enterprises filed for bankruptcy in the first half... 'Their failure will lead to unemployment and may threaten social stability,' says Frank Gong, JPMorgan Chase's Hong Kong-based chief China economist."

November 5 - Wall Street Journal Asia (Jonathan Cheng): "The financial crisis and China's slowing growth are hitting the cornerstones of Hong Kong's economy... On Monday, Hong Kong reported its closely watched purchasing-managers index fell to its lowest level in more than five years in October as business activity contracted for the fourth straight month... Hong Kong's retail sales rose 6.9% in September from a year ago...down from 10.2% in August..."

November 4 - Bloomberg (Kelvin Wong and Nipa Piboontanasawat): "Hong Kong's home sales posted the biggest drop by volume in almost nine years, as local lenders tightened mortgage lending amid a slowdown in the economy."

Japan Watch:

November 6 - Bloomberg (Naoko Fujimura and Tetsuya Komatsu): "Toyota Motor Corp... forecast the biggest drop in profit in at least 18 years... Net income will likely be 550 billion yen ($5.6 billion) for the year ending March 31, compared with an earlier forecast of 1.25 trillion yen... The new forecast will be a 68% drop from the 1.72 trillion yen Toyota earned last year."

November 5 - Wall Street Journal (John Murphy): "During Toyota Motor Corp.'s rapid global expansion this decade, residents of the auto giant's hometown saw their fortunes soar. Those days are quickly ending. Sales of Japan's biggest company -- widely seen as Japan's final bulwark against an economic slowdown -- are sputtering... The auto maker has slashed production and cut its temporary work force... by more than 20%... That has sent a chill across the Toyota City region, from its 400 car-related businesses to its real-estate market, department stores and noodle shops."

India Watch:

November 6 - Bloomberg (Sumit Sharma): "State Bank of India, which announced a cut in its lending rate today, said credit growth is unlikely to slow in the fiscal second half, requiring the government and the central bank to ensure adequate cash in the financial system. Loan growth in the six months ending March 31 is expected to match the 29% increase in the first half..."

November 3 - Bloomberg (Kartik Goyal): "India's exports grew at the slowest pace in 18 months in September... Overseas shipments, which account for about 15% of the economy, rose 10.4% to $13.7 billion from a year earlier..."

Asia Bubble Watch:

November 5 - Bloomberg (Kim Kyoungwha): "South Korea's won fell after the nation's foreign-exchange reserves slid by the most since its $57 billion bailout by the International Monetary Fund in 1997."

November 3 - Bloomberg (Kyung Bok Cho): "Park Ji Eun's dream of buying her first house in Seoul collapsed along with South Korea's shares and currency. 'I've never seen the economy so bad,' said freelance scriptwriter Park... 'I've worked on this program for eight years, and this is the first time I've ever had my pay cut.' From writers to builders to chief executives, the won's 26% slump and the Kospi stock index's 40% plunge this year has revived memories of 1997, when the government was forced to turn to the International Monetary Fund for a $57 billion bailout. Only this time, they say it will be worse."

November 7 - Bloomberg (Yu-huay Sun and Janet Ong): "Taiwan's exports fell by the most in more than three years on weaker demand in the island's biggest market, mainland China. Shipments dropped 8.3% in October from a year earlier, compared with a 1.6% decline in September..."

Latin America Watch:

November 5 - Bloomberg (Brian McGee): "Argentina froze a 2.4 billion-euro ($3.1bn) project to build a high-speed train from Buenos Aires to Mendoza because of a lack of financing, leaving contract winners Alstom SA and Grupo Isolux Corsan SA until May to revive the deal, Cinco Dias reported..."

Central Banker Watch:

November 5 - Bloomberg (Christian Vits): "The European Central Bank lowered interest rates for the second time in less than a month... ECB policy makers... reduced the benchmark lending rate by half a percentage point to 3.25%... The Bank of England today lowered its key rate by 1.5 percentage points to 3% and Switzerland's central bank lowered rates in an unscheduled move."

November 6 - Bloomberg (Elena Logutenkova): "The Swiss central bank cut its main lending rate by 50 bps and said the economy may contract next year. The central bank, led by Jean-Pierre Roth, lowered its three-month Libor target to 2% today from 2.5%..."

November 6 - Bloomberg (Christian Wienberg and Tasneem Brogger): "The Danish central bank cut its benchmark interest rate by half a point... Nationalbanken lowered the lending rate to 5%... after the ECB cut its key rate to 3.25%."

November 4 - Bloomberg (Jacob Greber): "Australia's central bank cut its benchmark interest rate by a larger-than-expected three quarters of a percentage point, the third reduction in as many months... Governor Glenn Stevens lowered the... target to a 3 1/2-year low 5.25%..."

Unbalanced Global Economy Watch:

November 7 - Bloomberg (Daniel Whitten): "Canadian oil-sands developers are cutting investment plans by 20% after a slew of delayed projects, an official at the main trade group for Canada's oil producers said..."

November 7 - Bloomberg (Wendy Leung): "Global ship orders tumbled 90% last month as the credit crunch damped world trade and made it harder for shipping lines to borrow money, according to Lloyd's Registers Group."

November 7 - MarketNews International: "There was a sharp rise in insolvencies in the UK in the third quarter, the latest government data showed. There were 4,001 compulsory corporate liquidations and creditors voluntary liquidations in England and Wales in the third quarter, a rise of 10.5% on the quarter and an increase of 26.3% on a year ago."

November 6 - Bloomberg (Brian Swint): "U.K. house prices fell at the fastest pace in at least 25 years... The average cost of a home dropped 14.9% from a year earlier in October..."

November 5 - Bloomberg (Svenja O'Donnell): "U.K. factory production fell for a seventh month in September, the worst streak for almost three decades..."

November 5 - Bloomberg (Colm Heatley): "Irish unemployment rose in October to the highest in more than 11 years, as a construction slump continued and the economy entered a recession... On an unadjusted basis, applications have increased by 94,502 in the last year, the biggest increase since records began in 1967."

November 5 - Bloomberg (Ian Guider): "Ireland's budget deficit almost tripled in the 10 months through October from a year earlier as a slump in home sales and consumer spending cut tax revenues. The shortfall of 11 billion euros ($14.3 billion)... compared with a deficit of 3.94 billion euros a year earlier... Total tax income fell 10% to 31.4 billion euros."

November 7 - Bloomberg (Gabi Thesing): "Industrial production in Germany declined the most in almost 14 years in September, increasing the likelihood of a recession in Europe's largest economy. Output dropped a seasonally adjusted 3.6% from August..."

November 4 - Bloomberg (Emma Ross-Thomas): "The number of Spanish companies in bankruptcy proceedings more than tripled in the third quarter as the credit crunch deepened the decline in the construction industry and edged the economy toward a recession."

November 4 - Bloomberg (Ben Sills): "Registered unemployment in Spain surged in October as the economy headed toward its first recession in 15 years. The number of people claiming unemployment benefits rose 7.3%..."

November 3 - Bloomberg (Emma Ross-Thomas): "Spain will allow unemployed workers to put off paying half their monthly mortgage payments for two years, Prime Minister Jose Luis Rodriguez Zapatero said..."

November 3 - Bloomberg (Johan Carlstrom): "Swedish manufacturing shrank at a record pace in October as the financial crisis sapped demand at home and abroad and companies reduced jobs..."

November 7 - Bloomberg (Nathaniel Espino and Marta Waldoch): "Iceland may receive a $6 billion financial aid package from a group led by the International Monetary Fund after the collapse of the island's banking system paralyzed much of its foreign exchange market."

November 6 - Bloomberg (Tracy Withers): "New Zealand's jobless rate rose to the highest in almost five years in the third quarter... The unemployment rate increased to 4.2% from 3.9%..."

November 4 - Bloomberg (Nasreen Seria and Mike Cohen): "South African vehicle sales fell an annual 30.1% in October..."

Bursting Bubble Economy Watch:

November 7 - Bloomberg (Bob Willis and Rich Miller): "The U.S. unemployment rate rose to the highest level since 1994 as companies slashed payrolls, setting the stage for the steepest economic decline in decades... The jobless rate rose to 6.5% in October from 6.1% the previous month... Employers fired 240,000 workers after a loss of 284,000 in September."

November 5 - Bloomberg (Timothy R. Homan): "Service industries in the U.S. contracted the most on record in October as credit dried up and consumers reined in spending. The Institute for Supply Management's non-manufacturing index, which covers almost 90% of the economy, fell to 44.4... the worst result since records began in 1997."

November 5 - United Press International: "The number of U.S. states in a recession or poised to fall into one has grown to 30... At the end of September, with Hawaii, Minnesota and Utah joining the list, 30 states have declining economies and five more Colorado, Massachusetts, Montana, New Hampshire and Texas have economies at risk, Moody's Economy.com said... 'There's no way around the map. It says the nation is in recession. The recession is coast to coast,' said Mark Zandi, chief economist and co-founder of Moody's Economy.com. 'One of the unique features of this downturn is how broad-based it is, regionally...'"

November 7 - New York Times (Stephanie Rosenbloom): "Sales at the nation's largest retailers fell off a cliff in October, casting fresh doubt on the survival of some chains and signaling that this will probably be the weakest Christmas shopping season in decades. The remarkable slowdown hit luxury chains that sell $5,000 designer dresses as badly as stores that offer $18 packs of underwear, suggesting that consumers at all income levels are snapping their wallets shut... Of the more than two dozen major retailers that reported on Thursday, most had sales declines at stores open at least a year, the majority of the decreases in double digits."

November 5 - Wall Street Journal (Kate Linebaugh and Matthew Dolan): "The dismal U.S. auto market took a turn for the worse in October, with sales plunging by about a third as the financial crisis and tightening credit kept buyers away from showrooms... General Motors Corp. said it was the worst October in 25 years. When adjusted for increases in the U.S. population, last month was 'the worst month in the post-World War II era,' Michael DiGiovanni, GM's top sales analyst, said... 'This is clearly a severe, severe recession.'"

November 6 - Bloomberg (Josh Fineman and Christine Harper): "Citigroup Inc. and Goldman Sachs Group Inc., faced with a weakening economy and the prospect of mounting losses, began firing workers as part of the firms' plans to cut more than 12,000 jobs, people with knowledge of the matter said."

November 5 - Wall Street Journal (Ben Casselman): "The sudden end to the energy boom is sending a shock through resource-rich regions of the U.S. that until now had been bright spots amid the nation's financial turmoil. The torrid pace of oil and gas exploration pumped billions of dollars into regions such as North Texas, bringing stronger housing prices, lower unemployment and soaring tax revenue... 'We were all sitting over here in a kind of blissful stupor enjoying a great market compared to the rest of the United States,' said commercial-real-estate broker Jack Huff. 'Until 30 days ago, there was no feeling at all that anything going on in the rest of the country affected us.' Not anymore."

November 5 - Bloomberg (Cotten Timberlake): "Luxury retailers may suffer the industry's biggest reversal of fortune during the holidays as the global financial crisis dents the wealth of the richest Americans. Sales at Saks Inc., Nordstrom Inc. and Neiman Marcus Group Inc. stores open at least a year may decline as much as 3% in November and December... according to the International Council of Shopping Centers trade group... The drop in demand may signal that America's wealthiest consumers are retrenching more than the rest of the country, avoiding luxury purchases while the U.S. loses more jobs and home foreclosures rise. 'Conspicuous consumption is less fashionable,' said Melissa Otto, a senior investment analyst at American Century Investments... 'There is a psychological ethos now that people don't want to jump out and be big spenders.'"

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

November 7 - Bloomberg (Jeff Kearns): "Business schools must change their teaching to embrace more empirical models instead of the risk management models that failed to foresee the worst market meltdown since the Great Depression, according to Nassim Taleb, the options trader turned 'Black Swan' author. Universities must change because they teach mathematical theories, such as the Black-Scholes model of pricing options, that don't express risk properly... Options are derivatives that give the right but not the obligation to buy an underlying security at a set price and date. 'Recent events have proved that all risk management was wrong,' Taleb said. 'We need to do something drastic immediately to stop quantitative risk managers from inflicting more damage.'"

November 3 - Wall Street Journal (Carrick Mollenkamp, Serena Ng, Liam Pleven and Randall Smith): "Gary Gorton, a 57-year-old finance professor and jazz buff, is emerging as an unlikely central figure in the near-collapse of American International Group Inc. Mr. Gorton, who teaches at Yale School of Management, is best known for his influential academic papers, which have been cited in speeches by Federal Reserve Chairman Ben Bernanke. But he also has a lucrative part-time gig: devising computer models used by the giant insurer to gauge risk in more than $400 billion of devilishly complicated deals called credit-default swaps. AIG relied on those models to help figure out which swap deals were safe. But AIG didn't anticipate how market forces and contract terms not weighed by the models would turn the swaps, over the short term, into huge financial liabilities."

November 3 - Bloomberg (Bradley Keoun and David Scheer): "UBS AG, Switzerland's largest bank, faces dozens of claims in the U.S. from clients who bought '100% principal protected notes' issued by Lehman Brothers... that are now almost worthless... State regulators are fielding so many calls about Lehman's notes they're considering a task force to investigate the sales, said Rex Staples, general counsel for the North American Securities Administrators Association Inc..."

Real Estate Bust Watch:

November 7 - Bloomberg (Sarah Mulholland): "Commercial real estate borrowers are running out of options as asset-backed markets dry up and alternative financing comes to an 'abrupt halt,' RBS Greenwich Capital Markets Inc. analysts said. Regional banks and insurance companies, which had become the primary source of financing since credit markets seized up, have stopped lending... Sales of bonds backed by commercial mortgages slumped to $12.2 billion in 2008, compared with a record $237 billion last year, according to JPMorgan..."

November 4 - Bloomberg (David M. Levitt): "New York City commercial real estate transactions plunged 61% in 2008 through October as the global credit crisis roiled lending and sidelined buyers... 'The banks are not lending, and most of them are saying we're done for the year,' said Scott Latham, executive vice president for... Cushman & Wakefield... 'In all likelihood, you will see next to no transactions between now and the end of the year.'"

November 3 - Bloomberg (Sharon L. Lynch and Jonathan Keehner): "Nowhere is the high-water mark of New York real estate more visible than the former Jehovah's Witnesses distribution facility at One Brooklyn Bridge Park. The 14-story condominium complex shattered the borough's price ceiling when real estate entrepreneur Elizabeth Stribling agreed in March to pay $6.05 million to live there. Now, two- thirds of the 449 units in the 1.2-million-square-foot building remain unsold... 'We were killed,' said Robert Levine, ceo of RAL Companies & Affiliates LLC, who masterminded the $550 million waterfront project..."

Speculator Watch:

November 6 - Bloomberg (Jeran Wittenstein): "Citadel Investment Group, the hedge fund company with $16 billion under management, has been asked by several banks to come up with more collateral to cover investment losses, the Wall Street Journal said, citing unidentified people. Citadel's biggest hedge fund has fallen almost 40% this year, causing the company to hold talks with lenders including Goldman Sachs Group Inc., Deutsche Bank AG and Merrill Lynch & Co., the newspaper said."

November 4 - Wall Street Journal (Gregory Zuckerman): "Pain in the market for convertible bonds is crippling big hedge funds and cutting off a key avenue of financing for many companies. This market, which has long welcomed businesses struggling to raise cash, is the latest to suffer from too much borrowing and faulty hedges, which came unwound in the recent turmoil. Overall, the $200 billion convertible-bond market has lost 36% so far this year... according to Merrill Lynch. But the average convertible-bond hedge fund has lost about 50% in that time, including a 35% plunge in October, according to Hedge Fund Research Inc. Buying and selling convertible bonds is a bread-and-butter trade for many hedge funds..."

November 6 - Bloomberg (Zachary R. Mider, Jonathan Keehner and Jason Kelly): "Cerberus Capital Management LP may forfeit control of GMAC LLC as part of a plan to convert the faltering auto-loan company into a bank with greater access to government funds... Cerberus is weighing a plan to distribute its GMAC stake to investors in its private-equity funds, according to the people, who declined to be identified... The tactic, one of several options under discussion, may enable Detroit-based GMAC to become a bank and get funding from the U.S. Treasury and Federal Reserve without subjecting Cerberus to banking regulations."

November 6 - Bloomberg (Tom Cahill): "Man Group Plc, the largest publicly traded hedge-fund manager, fell the most in London trading since at least 1989 after saying that assets under management declined by $6.6 billion since September. 'We've had what I would call neck-snapping volatility,' Chief Executive Officer Peter Clarke said... 'The market backdrop we have is the worst in a modern generation's memory.'"

November 5 - Financial Times (Henny Sender): "Carlyle Group, the private equity firm, this week warned a group of its investors that they were unlikely to see returns on their money soon. 'You should expect very few distributions from us,' said Bill Conway, Carlyle's co-founder and chief investment officer... Mr Conway also said: 'You should also expect very few new deals.' He added that asset prices did not reflect grim economic realities globally. The warnings come as investors grow increasingly concerned about the health of companies that private equity groups invest in. Carlyle noted that it was valuing its investment in ailing semiconductor company Freescale at 50 cents on the dollar and HD Supply at 65 cents on the dollar."

November 6 - Bloomberg (Jason Kelly and Gillian Wee): "Blackstone Group LP, the world's largest private-equity firm, posted the biggest quarterly loss in 18 months as a public company as the financial crisis eroded the value of the businesses and real estate it has acquired. The loss excluding some costs was $502.5 million... compared with a profit of $234 million..."

Muni Watch:

November 7 - USA Today (Kathy Chu): "As the volatile stock market eats away at the assets of public pension funds, states are moving aggressively to mitigate their losses. Some states are raising the amount that employers and employees contribute to traditional pensions... Others are freezing benefits or scaling back cost-of-living adjustments. The moves come amid states' ballooning budget deficits. Pensions' poor investment performance threatens to aggravate states' fiscal woes. 'When revenue is down and pensions are suffering investment losses, the budgets of governments are squeezed,' says Dave Slishinsky, a principal at Buck Consultants, which advises states on pension plans."

November 5 - Bloomberg (Darrell Preston and Michael B. Marois): "U.S. states led by California embraced municipal debt as they approved about $29.3 billion of new borrowing, representing about 79% of measures for which results were available. Californians approved at least $17 billion, including money for schools and loans to veterans... 'Voters generally, under most circumstances and in most elections, tend to be overwhelming receptive to bond proposals,' said Jennie Drage Bowser, a policy analyst at the National Conference of State Legislatures."

November 7 - Bloomberg (Adam L. Cataldo and Terrence Dopp): "New Jersey has increased its debt to about $32.7 billion and plans to sell an additional $7.7 billion of bonds in the next four years... The state had $31.8 billion of debt outstanding as of June 30, an increase from $29.7 billion a year earlier.... New Jersey's debt tripled in a decade..."

November 7 - Bloomberg (Martin Z. Braun): "Michigan's municipal bond yields have surged as investors demand higher yield premiums to compensate for risk of the faltering U.S. auto industry... 'The panic has painted the entire state as a sell,' said Matt Dalton, chief executive of Belle Haven Investments..."

New York Watch:

November 5 - Bloomberg (Henry Goldman): "New York City, reeling from financial turmoil on Wall Street, must roll back a property tax cut and reduce its workforce by 3,000 to help shrink a $4 billion budget gap over the next 18 months, Mayor Michael Bloomberg said."

California Watch:

November 6 - Dow Jones: "With California facing a ballooning budget deficit that has reached $11.2 billion, Gov. Arnold Schwarzenegger... proposed a $4.4 billion tax hike and $4.5 billion in spending cuts... He called for a special session of legislature to address the deficit. The cuts are said to include unpaid worker furloughs, the elimination of two paid holidays for state workers and spending reductions in several state programs, according to sources cited by the Sacramento Bee. The governor proposed a temporary 1.5% sales tax increase..."

November 4 - Bloomberg (Michael B. Marois): "California is running short on cash again as the worst month for the S&P 500 Index since 1987 sapped tax revenue from income and capital gains the state relies upon for its budget... California sold $5 billion of short-term notes Oct. 16 after taking record orders from individual investors. The state told those investors at the time that the budget Schwarzenegger signed one month earlier was expected to have a gap of $3 billion by fiscal year's end. Now they say that hole is likely to be much bigger..."

November 6 - Bloomberg (Michael B. Marois): "California Governor Arnold Schwarzenegger said his state's finances have deteriorated so rapidly that a budget he signed just six weeks ago already is $11.2 billion in the red and taxes must be raised. Schwarzenegger... proposed increasing the state's 6.25% sales tax by 1.5 percentage points as well as increasing oil severance and alcoholic beverage taxes and motor vehicle fees."

Crude Liquidity Watch:

November 5 - Bloomberg (Greg Walters): "Russian companies should carry out oil and natural gas sales in rubles in order to establish the country as a global financial center, President Dmitry Medvedev said... Both Medvedev and Prime Minister Vladimir Putin have advocated the ruble as a reserve currency and urged the nation's energy producers to move toward trading in the currency."

November 3 - Bloomberg (Matthew Brown and Shaji Mathew): "Saudi Arabia's inflation rate fell for a second month... Annual inflation in the largest Arab economy declined to 10.4% in September from 10.9% in August..."

Debt Trap:

The economy lost 651,000 jobs in three months. Auto sales have collapsed, and retail sales have "fallen off a cliff." And there is at this point little indication that Credit Availability will normalize anytime soon for household, corporate or municipal borrowers. While the extraordinary efforts by the Fed and global central bankers have loosened the clogged up inter-bank lending market, risk markets remain hopelessly paralyzed. The unfolding collapse of the leveraged speculating community continues to overhanging the marketplace. Securitization markets are still essentially closed for business.

We can continue to analyze developments in the context of two overarching themes: First, there is the implosion of contemporary "Wall Street finance." Second, the bursting of the Credit Bubble has initiated what will be an arduous and protracted economic adjustment. Each week provides additional confirmation of the interplay between the breakdown of Wall Street risk intermediation and the bursting of the U.S. Bubble Economy. This process has gained overwhelming momentum.

I know some analysts are anticipating an eventual return to "normalcy." The thought is that it is only a matter of time before "shock and awe" policymaking and Trillions of newly created liquidity entice investors and speculators back into risk assets. This view is too optimistic, and history offers an especially poor guide in this respect. By and large, the unprecedented growth in Federal Reserve and global central bank balance sheets is (scarcely) accommodating de-leveraging. Between the hedge funds, global "proprietary trading" and other leveraged speculators, it is not unreasonable to contemplate an overhang of (prospective forced and deliberate sales) of upwards of $10 Trillion.

It's popular to label Federal Reserve operations as a massive effort to "print money." Yet it is important to recognize that, at least to this point, the expansion of the Fed assets ("Fed Credit") is counterbalanced by the collapsing balance sheets of leveraged financial operators. The inflationary effects - the increased purchasing power created by the expansion of Credit - occurred back when the original loan was made, securitized, and leveraged by, say, a hedge fund. Today's ballooning central bank holdings (and TARP spending) may very well stem financial system implosion. This is, however, a far cry from engendering a meaningful increase in either the market's appetite for risk assets or the expansion of new system Credit in the real economy.

I don't want to imply that unprecedented monetary policy measures aren't having an impact. Overnight lending rates (Libor) were quoted at 0.33% today, down from a spike to almost 7.00% in late September. And at 2.29%, three-month Libor has dropped from early October's 4.82%. Other measures of systemic risk and liquidity premiums (including the 2- and 10-year dollar swap spreads) have dropped dramatically over the past month.

The problem is that the "unclogging" of inter-bank and "money" markets has had little effect on the Pricing and Availability of Credit for the vast majority of borrowers operating throughout the real economy. After ending September at about 650, junk bond spreads have surged to 950 bps. Investment-grade bond spreads are also higher today than at the end of the third quarter. Benchmark MBS spreads have changed little, while Jumbo mortgage borrowing rates remain elevated. Risk premiums for municipal borrowings have been reduced only somewhat from extreme levels. Unsound borrowers everywhere have little hope of borrowing anywhere.

There are complaints out of Washington that, despite oodles of bailout funding, the banks are refusing to lend. Well, total bank Credit has expanded $575bn over the past 10 weeks, or 32% annualized. Importantly, the asset-backed securities (ABS), collateralized debt obligation (CDO), and securitization markets generally remain closed for new business.

The heart of the matter is not so much that banks are refusing to extend Credit but that the entire mechanism of Wall Street risk intermediation has collapsed. After ballooning into multi-Trillion dollar avenues for Credit expansion, intermediation through the ABS and CDO markets is basically over. The convertible bond market has also badly malfunctioned, along with the "private-label" MBS marketplace. Wall Street's "auction-rate securities" has ceased as a mechanism for Credit expansion, along with myriad other avenues for securitization. And, importantly, derivatives markets, having evolved into an essential element of contemporary risk intermediation and Credit expansion, have suffered a devastating crisis of confidence. Scores of leveraged strategies are no longer viable. Indeed, Monetary Processes essential for funding broad cross-sections of the economy have completely broken down.

Even if banks had a desire to make the same types of risky loans Wall Street financed throughout the boom (which they clearly don't), it is difficult to envisage how bank Credit could today adequately compensate for the interrelated collapses in Wall Street risk intermediation and leveraged speculation. And unlike previous crises, no amount of rate cutting, liquidity injections, or policymaker jawboning will revive leveraged speculation. That historic Bubble and mania has burst, and it is now only a matter of waiting to dissect the devastation wrought by the unfolding run on the industry. A typical Federal Reserve-induced return to risk-taking in the Credit markets will be stymied for some time to come by an unrivaled inventory of debt instruments overhanging the markets.

The critical issue then becomes how the system can generate sufficient new Credit to keep our asset markets and Bubble economy from completely imploding. Well, we can assume at this point that the Fed will continue to accommodate de-leveraging through the ballooning of its balance sheet. At the same time, the federal government will soon be running Trillion dollar annual deficits. GSE balance sheets will likely commence a period of aggressive expansion. And, importantly, the banking system will have no alternative than to expand rapidly. At this point, timid banks equate to a Bubble Economy spiraling into depression.

If the markets cooperate, perhaps over the coming months the now breakneck economic contraction will somewhat stabilize. I fear, however, that current dynamics are setting the stage for yet another stage of this vicious crisis. Some analysts believe - and certainly it is the Fed's intention - for ultra-low interest rates to assist in the recapitalization of the banking system. The early 1990's provides a nice example: aggressive rate cuts and a steep yield curve provided a backdrop for troubled banks to quietly convalesce by raising cheap deposits and sitting on a safe portfolio of longer-term government debt securities. Why can't a similar operation bail the banks out of their current predicament?

One should note the stark contrasts between today's environment and that from the early nineties. First of all, 10-year government yields averaged about 7.8% in the three years 1990 through '92. Bond markets back then were commencing a historic bull run and, strangely enough, the price of government debt ran higher in the face of huge deficits. There are reasons these days to fear an emergent bond bear. Second, from the Fed's "flow of funds" report, we know that "Total Net Borrowing and Lending in Credit Markets" averaged $770 billion annually during the '90-'92 period. "Total Net Borrowing..." last year approached a staggering $4.40 TN. The important point is that today's Bubble Economy Dynamics were not in play in the early nineties. Sustaining the system required a fraction of today's Credit creation, thus there was little prevailing pressure on the banks back then to lend amid their "convalescing."

Indeed, banking system impairment and resulting Fed policymaking engendered the emergence of Wall Street finance in the early nineties - from the Wall Street firms, the GSEs, securitizations, derivatives and leveraged speculation. All were more than happy to take up the slack in bank Credit creation - signficantly helping to reflate both the banking system and the overall economy in the process.

With the Bursting of the Bubble in Wall Street Finance, the banking system will today have no alternative than to lend and expand Credit aggressively. The banks provide the only hope for reflation, and there will be no room for nineties-style risk-free government carry trades. Instead, it will now be the banking system's role to take up enormous systemic Credit slack and rapidly expand its portfolio of risk assets. Especially at this precarious stage of the Credit cycle, the banking system's predicament ensures the ongoing need for hugely expensive government funded industry recapitalizations.

In today's interest rate and market environment, massive government deficits don't worry the bond market. I view the marketplace as quite complacent when it comes to the scope of unfolding Treasury and agency debt issuance. Actually, the Treasury, the GSEs and the banking system have in concert succumbed to Debt Trap Dynamics. With Wall Street risk intermediation now out of the equation, the system is down to four principal sources of "money" creation - the Fed, Treasury, GSEs and the Banks. It's that old "inflate or die" dilemma that's already smothered Wall Street finance.

The good news is these sources of Credit creation do today retain the capacity to somewhat stabilize financial and economic systems. The bad news is that going forward all four must expand aggressively - in collaboration - to forestall acute systemic crisis. All four must expand aggressively to bolster a highly maladjusted economic system, in the process sustaining confidence in the value of their liabilities. At some point, one would expect a crisis of confidence with respect to the quality of these Credit instruments. And, you know, the way things have unfolded, Murphy's Law would only seem to dictate a destabilizing jump in market yields.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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